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Friday, October 28, 2005

China Expert Technology (CXTI) private placement

On Oct 21, 2005, CXTI (yahoo, website) signed this roughly 184 page agreement (don't bother looking for the actual numbers in that document because they're left blank) with a number of investment groups. This 8-K filing explains the terms of the agreement (if it takes 184 pages to say it precisely, you have to wonder how it can be condensed into a few pages without losing something).

$6 million of 7% convertable debentues (1 year maturity!) which are sort of like call options with a strike price of 75% of the recent stock price, but limited to no more than $1.80 (which for 1 year, the limit is probably not worth all that much). But in addition to these convertables, you also get 3.9 million handsome Short Term Warrants with a strike price of $1.53 and 18 months before expiration. But wait! You also get 1.96 million Long Term Warrants with a strike price of $3.06 and 5 years before expiration. These can all be yours if the Price Is Right (and you're one of the acredited participating investors).

So what is the value of what these investors are getting? The market says, "Way More Than Six Million Dollars!" because it drove the price of CXTI down by 20% after the announcement (or the market might be saying this is a sign of trouble).

Here's my extremely rough and possibly error-prone estimate of the value of what CXTI gave up in exchange for six million dollars. Well, I consider it extremely likely that CXTI will be able to repay the principal after 1 year (their current ratio is greater than 3). So I'd say the bonds might be [originally I said "probably" but I think that's definitely an overstatement] worth a premium, but we'll ignore that for now because the conversion itself is worth more. You might convert these shares at 75% of the recent stock price, but you'd push the price down quite a bit in selling them off. Let's say the conversion is worth 15% of the $6 million, or $900K, but let's round that up to a million. Using my great skill at valuing warrants (hah), I'll say the Short Term Warrants are worth $500K and the Long Term Warrants are also worth $500K. That's really close to my best guess and I've spent many hours trying to value LEAPs of various companies and comparing that to market prices. But the downside is that I spent almost no time trying to figure out the value of these CXTI securities.

So by my far-from-expert valuation and the back of a napkin-shaped envelope, I figure the company paid out $8 million in stuff for $6 million in cash. Is this a good deal? It depends on the opportunities for that cash. If I had a magic genie who could send me back in time by 3 hours and it was just after a big jackpot lottery event turned up no winners, if I didn't have any money at that time, I'd gladly write a check for $10,000 in exchange for a single dollar in cash. It's all about the cost of the money and the value of the opportunity. It could be that CXTI landed some big deal, but they needed X amount of cash on their balance sheet (the one year maturity sort of indicates something like this). But who knows? Maybe there was some huge shortfall in cash and the "opportunity" is simply not going bankrupt (like I said, far from being likely).

Without any more information, I have no idea whether this is a good deal or a bad deal. But given the cost of the six million dollars, they're going to need a very good opportunity to make it worth while.

UPDATE 20 minutes later: I just realized that the value of the convertables shouldn't be discounted because if you were to buy the same number of shares, you'd end up with an even higher cost basis than the recent stock price. I priced them assuming you'd want to dump them immediately. So I should probably add $600K to the number. Later on in the day I made more changes [with notes].

UPDATE Halloween: Well, I bought more shares (I had a very small investment in CXTI already). It's clearly worth 85 cents, in my opinion

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